08/29/2011

At a recent trading conference several traders were talking about exit strategies at lunch and one noted that he ‘liked to hold positions for about a week’. When asked why, he had no reason for the decision; it just ‘felt right’ to him. Trading on tips, emotions, or what ‘just feels right’ is unlikely to produce good long term results. Trading should be based on the careful analysis and testing of each trading system that a trader uses. Testing does not eliminate risk or guarantee results, but it can help to give a good idea of how a system has actually performed.

In trading range market environments I generally exit a position if the stock approaches the upper Bollinger Band or a horizontal resistance point. I do not want to hold out for the last dime, I want to be taking profits as the stock approaches resistance. In a trading range market it is generally better to get out too early than too late. It is tough to go broke taking profits. By definition the market usually retraces at resistance. If the market usually retraces from resistance then I want to be out of the position before it does and use the funds for another trade that is just triggering and starting its run.

Eventually almost all resistance areas are broken, but if the stock usually retraces at resistance then I want to go with the odds and be positioned to profit if the stock does the normal thing and retraces. If it does retrace I have my profits and can use them in a new trade. If the stock breaks above resistance I still have my profits and can still take another trade. From a risk management standpoint I am better off to have taken the profits. I am always trying to position myself to profit if the market and my positions do the normal thing. When something unusual happens I may loose a few bucks, but by definition unusual things do not happen often. One of the keys to trading is learning what usually happens in a given situation and then being positioned to profit if it does.

The successful trader has a tool box with a variety of trading tools for use in different market conditions. The trader, like the carpenter, must go beyond just acquiring the tools. Traders must understand which tool to use for a specific task, and have a clear understanding of how the tool works, and what can and cannot be done with it. I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy. Trading without this information is taking unknown risks.

07/17/2011

The market has three basic modes. It can be going up, down, or sideways. Over time the markets movement is made up of combinations of these three different behaviors. None of these behaviors lasts for long, the market is always switching between them. This is one of the keys to trading. Traders need to recognize that the market moves between these three modes and have the ability to recognize then the change has arrived and be able to switch to trading tools suitable for the new environment. This is a process I call Market Adaptive Trading. The market will not adapt to us. It does not care what we want or think. Therefor we must adapt to it.

If I know how a trading system, or trading tool as I refer to them, performs in each of the three different market conditions; then I can watch the market to determine what type of condition we are currently experiencing and then use the tools that have shown good results in that type of market condition. This is the process of Market Adaptive Trading. It takes some practice to quickly recognize the current market conditions, but this is a lot easier that trying to predict where the market is going.

No one has consistently predicted where the market is going over the long run. Remember all those empty suits on the TV news shows telling us everything was fine just before the 2008 crash. They did the same thing before the 2000 crash. Not even (or perhaps especially) the experts can successfully predict market direction consistently. However you can learn to look at a chart and tell if the market is going up, down, or sideways. And that is actionable information, as opposed to someone’s guess of where the market is going to be in three months or a year.

The successful trader has a tool box with a variety of trading tools for use in different market conditions. The trader, like the carpenter, must go beyond just acquiring the tools. Traders must understand which tool to use for a specific task, and have a clear understanding of how the tool works, and what can and cannot be done with it. I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy. Trading without this information is taking unknown risks.

07/09/2011

When traders get together and discuss trading patterns or setups someone usually asks why a particular pattern works. To explain trading patterns the market is often described as a battle between the Bulls trying to drive prices up, and the Bears trying to drive prices down. The patterns are the result of this contest between the Bulls and Bears. Some traders will start using a pattern or trading system when they hear an explanation of why it works that makes sense to them. We all have a need to understand why something should work. However, for traders it is more important to know how often a pattern works than an explanation of why it works. Knowing why a pattern works is interesting. Knowing how often a trading pattern works can be profitable. Knowing in what specific market conditions a pattern works best can be very profitable. The new column on ‘Data Driven Trading’ will be examining these issues on a weekly basis so that we can be focused on trading with knowledge instead of guesses or hunches.

In addition to knowing how often a particular trading pattern produces profitable trades, traders should understand if there are observable parameters that can strongly influence results. Some of the questions traders should address before using a trading pattern are: How long should a position be held? What are good profit target points? What type of orders should be used? Where should stop loss orders be entered? There are a number of effective tools for the trader’s tool box. However, like any other tool the user needs to understand exactly what it is designed for, and how to use it effectively. Carpenters can make beautiful things with a table saw; however they need to understand how to use it, and also know when another tool might be more appropriate for the task at hand. They also need to know the safety rules, how to avoid kickback, and the importance of using a push tool. At least the carpenters that still have all their fingers do.

Some traders gain a better understanding of trading patterns, and the environments in which to use them, though experience. After trading for a number of years they begin to understand what variations of a particular trading pattern work best, and which ones are more prone to failure. Experience often produces good results when we are listening closely, however it can be costly.

A less expensive way to develop an in depth understanding of how trading patterns work is by backtesting the pattern. Backtesting also allows us to test how simple variations or changes in the trading pattern effect results. Backtesting can be done over a variety of time periods and even in specific market conditions. The more traders understand exactly how and when their trading patterns work, the more effective use they will be able to make of each tool in the trading toolbox. The Timely Trades Letter provides additional information on trading tools and techniques on a weekly basis.

The successful trader has a tool box with a variety of trading tools for use in different market conditions. The trader, like the carpenter, must go beyond just acquiring the tools. Traders must understand which tool to use for a specific task, and have a clear understanding of how the tool works, and what can and cannot be done with it. I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy. Trading without this information is taking unknown risks.

07/02/2011

Many traders are interested in knowing how a trading system did last year, or the year before. If they see these numbers it makes them happy, and they feel that is what they should expect going foreword. When some people evaluate mutual fund, or money manager, performance they want to know how the performance was in each of the last few years. While this seems to make people happy, it does not mean much, or give a realistic expectation of what to expect going foreword. The reason is that the market is not the same from one year to the next. How the market, or a trading system, performed last year may have little to do with how it will perform next year. Looking at annual returns may be interesting, but it does not tell you how and when to use a trading tool.

I know traders who took significant losses during 2008, using techniques that showed strong results over previous years. They had developed these systems by looking at annual results over several years. When 2008 came along, and the market did not look much like it had the previous few years they experienced losses that wiped out the profits of several years of trading. I have seen traders that are looking for the hot hand, and when they find someone with good results in the previous year, they want that person to manage all their money because they think the hot hand will perform again next year. Strong results in the past year or two may have no bearing on next year if the market conditions change.

Rather than look just at annual results, I want to know how a trading system performs in bull and bear markets. No one knows what the market will do next year. Even the ‘expert’ economists have predicted ten of the last three recessions; they usually all over the financial channels telling you we are in a recession, or a boom period, after they have started. Few, if any, consistently predict them in advance. Driving while looking in the rear view mirror can be problematic.

The market has just three basic modes. It can be trending up, a bullish period, it can be trending down, a bearish period, or it can be just moving sideways, a trading range period. During the testing and evaluation of numerous trading systems I have seen that the market conditions, bullish, bearish, or trading range, have a strong effect on most systems. Because of this I have developed different trading systems for each of the three market conditions and refer to the collection of trading techniques as my trading tool box. The markets overall movement is made up of a combination of bullish, bearish, and trading range periods. Years are convent for us to mark time, but the market does not care about them. It simply moves in combinations of bullish, bearish, and trading range periods. It is hard for it to do anything else.

The successful trader has a tool box with a variety of trading tools for use in different market conditions. The trader, like the carpenter, must go beyond just acquiring the tools. Traders must understand which tool to use for a specific task, and have a clear understanding of how the tool works, and what can and cannot be done with it. I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy. Trading without this information is taking unknown risks.

06/12/2011

During 20 years of active trading experience I have researched, tested, and analyzed a number of trading systems and techniques. Some have shown promising results, some do not. I add tools to my trading toolbox based on their effectiveness. Trading systems are not effective because Aunt Millie or uncle Bob told you about them, they are effective because they work. Most trading systems are affected by market conditions, volume patterns, and other factors. Successful traders know how these parameters affect trading results, so they know when to trade a particular pattern, and when to use another tool in their toolbox.

Making money in the stock market requires knowledge of what to trade, when to trade, and a variety of trading tools designed for different market conditions. Just as a carpenter will use several different tools when building a house, traders will use different tools to build their account. Using the same trading tool in all situations is like trying to build a house with just a hammer. Carpenters have tools designed for specific jobs, and so should traders. Testing and analyzing potential trading systems allows traders to select the ones most appropriate for the current market environment.

The successful trader has a tool box with a variety of trading tools for use in different market conditions. The trader, like the carpenter, must go beyond just acquiring the tools. Traders must understand which tool to use for a specific task, and have a clear understanding of how the tool works, and what can and cannot be done with it. I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy. Trading without this information is taking unknown risks.

05/25/2011

I got an interesting email from a potential trader who was concerned that trading might ‘take too much time’. Apparently the new bailout mentality in the country has people thinking they should be able to make a lot of money quickly with little investment in education, tools, or experience. Trading, like most other professions takes time to learn. It will take a couple of years, not a couple of weekends, to learn the process of trading. It takes time because traders need to see how things work in different market conditions, and it takes time for the market to cycle between these different conditions. On the other side, the actual trading process does not require one to be glued to a computer all day, it can generally be done in minutes. The trading systems I use are based on end of day data. They have been developed and tested by looking at daily patterns, not five minute charts. Since I trade the daily patterns, I do not need to see the five minute charts. I run the scans, pick the setups, use market conditions to determine whether to focus on longs, shorts, or cash, and then implement the trading plan. It takes me less than thirty minutes to check the setups on the watch list if I do it manually, and less time if I have my broker text me alerts when a setup hits a price level of interest. It takes time to learn trading just like it takes time to learn to be a doctor, engineer, or electrician. Once the trading skills are learned, the actual time spent trading can be quite short.

Holding periods and profit taking should be based on current market conditions. Take profits quickly in trading range markets, and give positions more time to work in trending markets. In non trending markets holding periods are usually not more than a few days. In trending markets holding periods may be several weeks or months. In non-trending markets consider taking profits after the initial pop from the trigger. Look to exit as the stock approaches the Bollinger Band, a recent high, a trend line, or when the market approaches support/resistance. In trending markets, consider trend lines and major support/resistance areas for exits. Strong stocks move up on above average volume. If the volume is low when moving up consider taking profits. When in doubt take profits. There is no guaranteed technique that always works, watch the setups that are triggering and adjust accordingly.

In order to find out what the usual, or normal course of action is, I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy.

05/15/2011

Successful traders examine the current market conditions to determine if they are bullish, bearish, or a trading range environment. Traders can determine which of the three modes the market is currently in by looking at a daily chart of the market action over the last year, using the 5X20 moving average filter, or through trend line analysis. I use each of these techniques for my own trading, and publish the analyses and trading setups in the Timely Trades Letter. After determining the current market environment, traders can select the tools from the their trading tool box that perform best in the current conditions. Having multiple trading tools that have been carefully tested and analyzed in each of the major market conditions is a key part of successful trading. If you trade the same tool all the time, or do not adapt to changing market conditions, you may get a lot of practice exercising stops.

Pullbacks are one of the bread and butter techniques of trading because they occur frequently and can be found in most market conditions. Most traders should have more than one pullback system in their trading tool box. There are interesting pullback systems based on the percentage of retracement, pullbacks to key moving averages, pullbacks for a specific number of days, and pullbacks with specific volume patterns. Specific pullback techniques and information on how they perform in different market conditions is covered in ‘How to Take Money from the Markets’. The book also shows specific techniques for adapting trading strategies and techniques to the current market conditions.In addition to adapting to the current market conditions by using the appropriate tools from the trading tool box there are several practical aspects of trading that traders need to master.

Never enter a position without having a plan for exiting the position. If you Do not know where to get out of a position you should not enter it in the first place. In swing trading time frames stocks often run to the next resistance or Support level and then stall. Stocks rarely remain outside the Bollinger bands for long, so when a position reaches the Bands it is often a good place to look at profit taking, especially in trading range environments. There is usually no need to rush in when the markets trend changes. Any trend worth trading does not require you to be in on the first day, by definition. Make sure that your position sizing is such that if all your current positions were stopped out that the total loss is something that is still comfortable. This happens from time to time, wishing it did not will not change it. Be prepared by using sensible position sizes.

05/09/2011

Traders do not earn their money sitting in front of real time charts all day entering trades. Traders earn their money by carefully analyzing potential trading systems and finding ones that show profitable trades more often than not during specific market conditions. Identifying and developing trading systems with an edge is a lot of work. Making the trades is the easy part. Many traders skip the hard part, focus on the easy part, and end up losing money because they have not put in the effort to develop trading tools that provide an edge.

In order to have an edge, traders need to know what the usual outcome of a particular trading pattern is in each of the three basic market environments. Beginning traders often are looking for the magic indicator that shows winning trades all the time. Those perfect indicators do not exist. Trading is a statistical business, it about knowing the odds and being positioned to profit from the usual or normal course of action in a given situation.

In order to find out what the usual, or normal course of action is, I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy.

Once a trading system is fully analyzed, and it’s behavior is like an old friend, then a trader can consider adding it to his trading tool box. When a trader has multiple tools for each market condition in his tool box he is ready to go to work. Trading without understanding how specific systems have performed in different market conditions is taking unknown risks, and often leads to poor results.

05/07/2011

Trading is about risk management. Traders learn how to manage risk by testing different trading strategies to see how they have performed in different market conditions. Testing trading strategies also helps to identify various volume and price patterns that may improve trading results in each of the three key market conditions. Volume patterns improve the statistics for many trading patterns. Strong volume and price patterns do not guarantee a result, nothing does, but they may improve the odds as demonstrated by the research presented in ‘How to Take Money From the Markets’. Using well researched price and volume patterns can be ways to manage risk. The research can also be helpful in determine which of several trading systems or tools may be the most appropriate for the current market conditions. One way to know what may or may not improve the results for a given technique is to understand how different price and volume parameters, along with different market conditions effect trading results. That is why I wrote ‘How to Take Money From the Markets’.

When the market is rocking I generally just enter strong setups without worrying much about the volume on the entry day. When the market is moving strongly then pullbacks, flags, and some of the other patterns I have tested generally mark pauses in the trend. If the pattern is generally a pause in the trend, then the odds are with me; and I do not need the confirmation provided by strong volume on the day of the trigger. When the market is more uncertain then I want to use additional tools to increase the odds of a favorable result, and I select the most appropriate tools based on the research presented in ‘How to Take Money From the Markets’.

How stocks and the market behave around the Bollinger Bands is very important to understand. Based on extensive testing I have learned to take profits in uncertain markets when my position becomes extended above the upper Bollinger Band. If you want a good lesson on risk management and why I exit positions that become extended above the upper Band take a look at the recent action in SLV. I did not get all the profit from the run up because the extension above the upper band had me out a week before the peak. However I still have my profits, and anyone holding last week took a thirty percent hit. I trade the charts and manage risk based on what I have learned from extensive testing.

04/09/2011

I get emails from traders who just want to focus on swing trading, intermediate term trades, stock trades, or ETF trades. I am not sure how they have decided which is best, since the results of these different techniques can vary with market conditions. It makes more sense to have techniques for stock and ETF trading and be able to make swing trades and intermediate term trades and then adjust the relative account sizes based on what is working in the current market conditions.

Most of the recent ETF selections in the Letter have triggered and moved into profitable positions, which is why I rotated additional funds to the ETF account as noted in previous Letters. I want to move funds into what is working in the current environment. When the market is sluggish swing trading stocks slows down for obvious reasons. However even in sluggish markets we see some of the ETFs moving, so I put more focus there until the market finished resting and decides to move again. When the market is strongly trending there is usually more bang for the buck in swing trading stocks than ETFs so I rotate funds into the swing trading account. This sounds obvious, but sometimes traders get fixated on just one technique and don’t look at the bigger picture.

Adapting our trading tools and techniques to the current market conditions is one of the keys to trading success. Guessing the markets next move, or using the same trading tool (technique) all the time, can lead to poor results. By having swing trading and ETF trading accounts I have the ability to focus on trading ETFs when the market is sluggish and swing trading is slow. I can then move more into swing trading, with less focus on ETFs, when the market is strongly trending again. By just using one tool traders will have periods when they sit in cash for awhile waiting for the market to move.

In the current environment we see energy and commodities moving strongly (check out the strong profits from the recent GLD, OIL, XLP and SLV ETF trades as an example) Since we are seeing strong action in the energy and commodity areas I will look at a couple of swing trades of stocks in these areas if they trigger on increasing volume. There are a number of interesting setups in energy and commodity stocks like the ones in HMY, NFG, CVX, APA, and DVN. Given the markets recent positive volume pattern, shorts are not attractive unless the market starts showing strong distribution

The net change for the last six sessions is less than a one point movement, this is a very tight base. Tight bases often lead to strong moves, so while this is a time to keep the powder dry as noted in previous Letters. It is also a time to get the watch lists up to date and ready for the move that is coming. When the market, or individual stocks, approach a resistance area it is usually a good idea to focus on protecting profits made during the last run. When the market approaches resistance it usually bases or retraces a bit. If most of the time the market stalls, or retraces, around resistance then it is best to lock in some profits; and let the market set up for the next move. If the market breaks above resistance we will still have our profits and can take new positions. If the market retraces from resistance then we still have our profits, and will have avoided potential losses. If you hold when the market approaches resistance you risk losses if the market pulls back. For more market analysis and trading setups click here.